We have a few rules/mental models that we run through before each trade at Volmanac. We are a firm believer in checklists and want to share some of the thoughts we have when entering and exiting an investment:
1) Assuming no new information, if this asset/trade falls in value do we want to buy more?
This is often only theoretical, as usually there is some catalyst / macro change if a position is down substantially. However, if we had the means to buy more and didn’t want to, that is a real problem. In almost every successful investment we have made, we hoped the asset would become cheaper in the short term so that we could buy more. We will be reluctant to enter into a trade if we would not add at a cheaper price.
2) View Asset/World 12-18 months out.
We imagine turning a corner and entering a world in which the catalysts have played out as we expected. Where is the asset trading and how are similar assets priced? What will the market and the general economy have to have done for this to happen? Conversely, if our thesis is incorrect, what risk factor did we underestimate and why? What does the market this of the asset now? While we can never hope to anticipate every risk, going through as many risk factors and scenarios as we can dream up is very valuable not only from a risk standpoint but also a trade construction standpoint as there may be a more efficient way to express a view.
3) Why / how do we have an advantage? How are other people viewing this asset/trade?
If we think there is a mispricing, why is it present? Is the market in general cheap? Do we think we have an advantage based on early data or data analysis? Do we understand the fundamentals better? Why do we understand them better? What will it take for others in the market to view this asset as we do and when potentially will that happen?
4) Do Not Exit Winners Too Early.
It is tempting to sell winners early to lock in a profit, but then you are always capping your gains which is extremely damaging for returns. This was more applicable when I was a trader and forced to provide liquidity. In order to accomplish the latter, I need to more aggressively offer profitable positions, which resulted in me missing out on additional gains.
5) Do Not Be Cute Entering/Exiting Positions
If we want to enter or exit a trade, we do not mind paying bid offer. We are an investor, not a market-maker.
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